Newsletter: May 2012
Welcome to the May newsletter
Wednesday’s growth figures demonstrate clearly the
considerable challenges facing the UK economy. Coming
just a day after the European backlash against austerity saw
the collapse of the Dutch Government, the –0.2% growth
estimate has put the Chancellor’s June 2010 strategy under
considerable political pressure.
He needs a growth strategy that gives the economy a
much-needed boost but without adding to the deficit. In
the last newsletter, Ian Mulheirn outlined the basis for such
a plan: an increase in growth-boosting infrastructure
funded either by temporary tax rises or by cutting lowgrowth measures.
Two weeks ago the International Monetary Fund came out
in favour of the same approach in its recent World
Economic Outlook. Ian Mulheirn looks today at why this
plan can help the Government out of both a political and
economic hole (see page 2).
A potent growth plan is the best way to boost the UK
economy and strengthen the public finances in the coming
years, but other policy challenges cannot be ignored. In the
long-term we may all be dead, but before then we’ll be
retired. So policymakers also need to consider long-term
trends that will affect households’ private finances.
With automatic enrolment due to begin later this year, the
SMF’s Nigel Keohane is leading a scenario planning project

looking at the forces that will determine household savings
over the next 20 years, and how policymakers might need
to respond. Nigel discusses some of the emerging themes
on page 4.
In higher education, with the new fee regime kicking in
from this September, Ryan Shorthouse looks at the
importance of helping students assess quality and value for
money in HE (see page 5).
And as the London Mayoral race reaches its climax this
week, we take a look at a version of the SMF’s plan for lowcost loans for childcare being proposed by Ken
Livingstone. Ryan Shorthouse looks on page 7 at why the
national political parties should take up the idea.
This newsletter also contains information about our exciting
events programme. We are pleased to be welcoming a
number of excellent speakers to the SMF over the coming
weeks, including US economist and bestselling author
Robert Shiller and also Ha-Joon Chang, Anna Vignoles
and John Van Reenen. Be sure to regularly check our
website or sign up online for updates so you can be first to
book.
Finally, party conference season will soon be upon us so
take a look at our information on page 7 and find out how
the SMF can work with you at this year’s party
conferences.

Director’s Note: Osborne’s alternative
Mulheirn
Director’s note: Recovery Ian
ahoy?
Ian Mulheirn
Wednesday’s growth figures were as bad as anyone could
have anticipated. And while there’s a good chance that
they’ll change – the recession could yet be revised away –
none of this alters the fact that the UK economy is in the
doldrums. Being economically becalmed is bad enough,
but we’re even slipping into a recession without a
meltdown in the Eurozone.
As navigators know, one risk of being stuck in the doldrums
in a ship under sail is your vulnerability to rapid climatic
changes such as violent storms and hurricanes. If the Eurosquall gets worse, we’re in deep trouble. So the question for
Captain Osborne is how he plans to get us underway.
Back in June 2010, at the emergency budget, the
Government’s plan was to allow loose monetary policy and
a devalued sterling to boost exports and hence stimulate
corporate investment. In other words our neighbours
would tow us out of the doldrums and into the trade winds.
But unremitting bad news from our main trading partner,
the Eurozone, hasn’t helped and growth there looks as far
away as ever.
That’s not the government’s fault, but it has rather sunk
their strategy. The growth part of the plan has failed and
needs a rethink. If foreigners won’t help out HMS UK, we’re
going to have to get back to fair winds under our own
steam. But with households and government retrenching,
it’s hardly surprising that UK corporations have no incentive
to invest.
The government has staked its reputation on ending the
deficit. And it’s taken as self-evident by most commentators
that a deficit reduction strategy (austerity) is the antithesis
of a growth strategy (fiscal stimulus). On this reading, the
question is only about how much more bad data it will take
before Mr Osborne junks deficit reduction and opts for a
borrowing-fuelled stimulus.
In response to yesterday’s figures the Treasury’s response
was that ‘one thing that would make the situation worse is
more borrowing’. The Government’s attachment to deficit
reduction is unwavering. The Chancellor isn’t going to ditch
the deficit reduction plan.

Respected UK advocates of a deficit-funded stimulus,
including the FT’s Martin Wolf, NIESR’s Jonathan Portes and
Simon Wren-Lewis of Oxford University, point to mounting
evidence that this adherence to austerity may be a mistake.
But putting the economics of whether the policy is wise to
one side, it’s clear that, politically, such a tight u-turn would
cause HMS UK to list so badly as to imperil the government,
quite apart from leaving Mr Osborne’s career on the rocks.
So what’s needed is as much a political as an economic exit
strategy for the government. One that allows the Chancellor
to stick to the deficit plan while also providing a massive
fiscal boost in the form of infrastructure investment.
If you subscribe to the conventional wisdom about the
stimulus or austerity binary choice, there is no such exit
strategy.
That’s wrong. Deficit hawks can also engineer a fiscal
stimulus through infrastructure investment, funded by
cutting low-growth spending and temporarily raising taxes.
The two are not opposites. If the Chancellor followed the
SMF’s funded stimulus plan, or indeed the last week’s advice
from the IMF on this, he could rightly claim a much bigger
stimulus than that being proposed by Labour while sticking
rigidly to the deficit reduction plan – as politically he must.
The macroeconomic debate about growth is largely
apolitical. But only a combination of good politics and
economics will give us a growth plan worthy of the name.
The clamour for the Government to throw deficit reduction
overboard doesn’t offer the Chancellor the needed facesaving solution. His opponents may as well ask him to walk
the plank. Nor would mutiny be in anyone’s interests right
now, with sovereign debt markets in
their current febrile state. A funded
stimulus plan to get the economy
moving again provides the political and
economic answer. The Chancellor
should take it.

Forthcoming SMF events
Professor Robert Shiller: Finance and the Good Society
Committee Room 2, House of Lords | 12.45pm
Top US Economist Robert Shiller, who famously predicted the dot-com crash and the sub-prime
bubble, will explore the themes in his new book Finance and the Good Society. The Times columnist
Philip Collins and Oxford University Professor Avner Offer will respond.

Chalk+ Talk: Ha-Joon Chang - Towards a selective industrial policy
SMF, 11 Tufton Street, SW1P 3QB | 12.30pm
Ha-Joon Chang, author of "23 Things They Don't Tell You About Capitalism" and Reader in Economics
at the University of Cambridge will discuss industrial policy and what role governments can play in
fostering innovation in industry.
Contact: rbaker@smf.co.uk / 0207 227 4404 or visit www.smf.co.uk/events

Paying your dues: should we be charitable to tax avoiders?
SMF, 11 Tufton Street, SW1P 3QB | 08.30 am
The last in the SMFâ&#x20AC;&#x2122;s series of three breakfast roundtables on tax avoidance and evasion, this event will
look at the cap on charity tax relief and ask whether the policy will have unintended consequences.
Contact: rbaker@smf.co.uk / 0207 227 4404 or visit www.smf.co.uk/events

Tomorrow’s savings: later, longer, less
Nigel Keohane, Deputy Director
There has been much criticism in recent weeks that the
March Budget offered only piecemeal reforms to
promote economic recovery. A similar criticism could be
made about other long-term challenges that are
unaddressed such as the need to re-build the financial
resilience of UK households and the growing costs of
longevity.
It is clear that UK households had insufficient savings to
insulate themselves from the economic crash at the end
of the last decade, with almost a quarter of British
households without any liquid savings. The low level of
active pension saving is also well known.
Despite this, there remains little understanding of
whether households will reform their ways and save
adequately in the future. Or which parts of the
population public policy makers should really be
worrying about.

continue to work, something that may become an
important political pressure point in the years ahead.
Twenty years from now, younger workers and even
those approaching middle age are likely to feel the
weight of student loan repayments, delaying their
savings in pension schemes, as the impact of the 2012
HE funding reforms kick-in. This may prove to be just one
of the ways in which government becomes more
involved in helping people to smooth consumption over
their lifetimes.
Meanwhile, the long-term trend towards older
homeownership, combined with housing supply
constraints, will see many unable to build their assets
through property. While they may not be exposed to
many of the housing-related risks that hit households in
recent years, it is also unlikely that they will be able to
use property as an asset.

To address these questions, SMF is carrying out research
looking at the long-term trends that will determine
savings adequacy twenty years from now. This indicates
that the convergence of a series of long-term
demographic, economic and social trends is set to pose
significant new challenges, risks and opportunities.

Twenty years from now, younger
generations are likely to feel the
weight
of
student
debt
repayments, delaying their savings

SMF is carrying out research looking
at savings adequacy twenty years
from now

These are just a few of the dynamics we’re exploring. Our
research indicates that there are other factors that are
potentially no less important but where there is greater
uncertainty: will economic growth return speedily? How
quickly
will
heavily-indebted
households pay down their debts?
Will the Government’s autoenrolment succeed in reversing the
decline in workplace pensions? In
large part these are unknowables,
but it doesn’t mean we should not
try to think through the
eventualities and plan accordingly.

To take a few examples: by 2032, people will be living on
average three years longer, whilst participating in less
generous pensions as defined benefit schemes peter
out. This will leave people having to work later to build
up an adequate pension pot. For many this may be as
much an opportunity as a threat. However, some groups
– for instance those in manual jobs or in sectors less
amenable to flexible part-time work – will struggle to

Getting bang for students’ buck
Ryan Shorthouse, Researcher
Liam Burns, re-elected the President of the NUS last week,
wants to shift his organisation’s focus away from tuition fees
to the quality of teaching students receive. Good. With
most institutions tripling their fees, it’s time to make sure
students get value for money.
Whilst NUS have been busy directing their anger towards
government, they have missed the real problem that needs
addressing. It’s not that the new fee arrangements are
putting off students from poor backgrounds. Rather, it’s
that despite fees unlocking greater revenue for universities
over the past decade, the average level of student
satisfaction – as measured by the National Student Survey –
has flatlined.
Government is hoping that students will become more
discerning
customers,
shunning
poor-performing
institutions, to incentivise universities to offer a better
quality experience. But students need to be able to make
informed choices.

sector, need to prioritise these indicators in their
assessments of institutions.
But giving applicants the tools to choose wisely is not
enough. This is because there is still a cap on university
places. Since demand for HE places forever exceeds supply,
poor-quality universities are in effect guaranteed customers.
So there is little incentive for universities to improve their
service.
The priority must be to finance the abolition of the cap to
ensure universities are required to respond to the needs of
their students. In the absence of complete liberalisation, an
alternative would be to make university funding for
undergraduate tuition dependent on revenue from
subsequent graduate earnings. The SMF advocated this
approach in Funding Undergraduates: with universities
taking out loans, rather than students, the amount they
borrowed would be entirely dependent on how each
cohort of their graduates performs in the labour market.
Such a payment by results model, with high-performing
universities able to borrow more, would encourage
institutions to invest much more in the quality of provision,
regardless of any cap on student numbers.

Despite fees unlocking greater revenue
for universities over the past decade, the
average level of student satisfaction has
Even though fees have increased, there is
flatlined
no guarantee that students that will have
Sadly, there is currently a lack of good, reliable data.
Employment outcomes are not good enough on their own. an enhanced experience
Impressive graduate salaries may be the result of the type of
students the university is able to attract, or their decadesold reputation among employers, rather than any reflection
of their contribution to the human capital of their students.
League tables use a range of indicators – such as spend per
pupil and entry requirements – but, again, many of these
may not be a measure of what the university adds, but a
simple reflection of their status.
Fortunately, research by Graham Gibbs has found there are
good proxy measures of how universities are performing,
such as class sizes, teaching standards, and the quality and
quantity of feedback. Students need to be directed to this
information. And QAA, the regulator of teaching in the

And competitive pressures need not apply only at the point
of admission. If external degrees were much more
widespread and normalised, as the Universities Minister
wishes, it could mean that students are much more able to
pick and choose modules and courses
at different institutions.
Even though fees have increased,
there is no guarantee that students
will have an enhanced experience. If a
liberalised HE market is some way off,
there are other ways to strengthen
competition if we wish to drive up the
quality of HE for students.

Avner Offer talks to the SMF on the
economy of obligation and
the welfare system
Chalk + Talk is the Social Market Foundation’s lunchtime
lecture series, bringing the best policy output from the
world of academia right into the heart of Westminster.

But reliance on contracts is not without its dangers, and
these attempts to lock in the future are far less effective
than economic theory would have us believe.

Launched in July 2011, these regular roundtable talks
have seen a distinguished line-up of academics present
their policy thinking on topics from competition in
healthcare to unemployment.

Contracts project into unknown future, where original
obligations can be relaxed as a result of litigation or
public policy. Not only that but people’s myopia and
problems of asymmetric information mean that many
can find themselves insufficiently protected. Moreover,
financial contracts are often seen as cheap alternatives to
government provisions, but this is far from true –
intermediation fees and civil litigation are expensive
transaction costs that state systems do not incur. For
example, according to US statistics, civil litigation costs
0.75% of GDP for transfers of 1% of GDP.

At the most recent event, on 26 April, Professor Avner
Offer discussed his latest paper, The Economy of
Obligation: Indeterminate Contracts and the Cost of the
Welfare State .

Offer argues that the state is therefore better placed to
respond to social needs. PAYGO does not try to lock in
the future but instead encourages cooperation as
individual transmissions over time (as in a private
pension, for example) are converted into transfers
between different sections of the society at each point in
time (working age taxpayers fund state pension
recipients). The level of these transfers is then
appropriately varied in response to the will of the
electorate.
A huge part of western governments’ expenditure is paid
out in social transfers financed on a pay-as-you-go basis.
But do private insurance markets offer a more efficient
way to organise such protection?
Professor Avner Offer of All Souls College, Oxford, argued
that governments are more reliable than markets when it
comes to managing social risk. Financial markets
promote transmitting risks over the individual life cycle
using financial contracts for future or contingent delivery.

One question that arises from this analysis is whether the
state is always robust in this role. The state is arguably
vulnerable to capture by finance, in this case arguing for
the superiority of market-administered social transfers.
But policy is also vulnerable to the myopic choices of
voters and politicians, and its actions are limited by
taxable capacity, intergenerational generosity, and
demands of security. In light of the limitations of both
the market and the state in this area, it seems inevitable
that neither can do the job alone.

Livingstone’s childcare funding
scheme: a step in the right direction
Ryan Shorthouse
Since the SMF launched the idea for a low cost loan to help
parents cover the significant upfront costs of childcare,
there has been considerable interest in the idea from
academics, policymakers and politicians alike.
Soon after The Times reported that the idea was being
seriously considered by the Treasury, Labour’s London
Mayoral Candidate Ken Livingstone proposed a version of
our idea if elected.
Under the SMF’s proposed National Childcare Contribution
Scheme, all working parents would be able to access up to
£10,000 from government to pay for their childcare costs
for children under the age of five. They would repay this
money on an income-contingent basis where the main
earner contributes 6% of their gross monthly income above
the personal tax allowance. An interest rate of 3% above
inflation would be applied and contributions would end
once all the assistance has been paid in full, or after 20
years, whichever is earliest.
Modelling conducted for the report shows the surplus from
the interest rate would cover the shortfall from write-offs
after 20 years of the lowest earners, making the scheme
costless to government. 57% of parents who expressed an
opinion reported that they thought the scheme was a good
idea and just over a quarter, across all income groups, said
they would use the scheme if it were available.
Livingstone’s policy of distributing grants and interest-free
loans to a select number of parents to help them afford
upfront childcare free is therefore a hugely welcome step
for Londoners. But what Ken Livingstone can’t do, if elected
Mayor, is extend the benefits of this scheme to the wider
taxpayer and to parents living outside London.
The SMF model is a national scheme, which brings many
advantages over the scheme Livingstone can propose. It
would entail lower capital costs because it uses the
government balance sheet and collects contributions
efficiently and cheaply via the tax system. This means the
interest rate charged to parents is lower than in a
commercial scheme.

The income-contingent nature of the SMF proposal would
also protect families who could no longer afford to repay.
Livingstone’s scheme by contrast will be more risky for
parents with repayment due whatever the family’s financial
circumstances.
Due to the inevitable constraints of a localised scheme,
Livingstone’s interest-free loans would be only available to
10,000 families, and the proposed grants to just 1,200
families. The eligibility for the proposed support is
contingent on having a household income below £40,000
per year. But research clearly shows that families across
most of the income spectrum struggle with childcare costs.
A national scheme could cater for all working families and
even make the policy pay for itself.
Limiting the eligibility to lower-income families increases
the risk of bad debt, driving up the interest rate for
borrowers for any given level of cost. As Livingstone
proposes interest-free loans, the cost of the scheme per
family will be significant. But by applying a low interest rate
and allowing better-off families into the scheme, a national
version of the Livingstone plan could be made to cover its
costs. Polling for our report showed a roughly equal mix of
parents from different social backgrounds are keen to take
advantage of such a national scheme.
Livingstone’s proposal offers grants and loans to cover
upfront fees. These fees can be punishingly expensive so
this is particularly welcome. But on-going costs are an even
bigger problem for families in London and elsewhere. The
SMF scheme proposes that parents be allowed to draw
down up to £10,000 to cover any type of childcare cost.
Ken Livingstone is right to propose loans to help parents
smooth the high costs of childcare, particularly in London.
While his scheme is a step in the right direction, it is
inevitably limited by being a local programme. The Labour
Party, now it has launched its Childcare Commission, would
be wise to scale-up the idea to a national level. Our report,
A Better Beginning, offers a blueprint for how.

Party Conferences 2012
At the half way point of the electoral cycle, this year’s
party conference season will be a crucial opportunity to
reflect on the Coalition Government’s record so far and
to contribute to the developing policy agenda.
The Olympics and the Queen’s Diamond Jubilee will
place Britain firmly in the international spotlight this year.
But, with the UK now officially back in recession, rising
dissent over the Government’s reform agenda in areas
from health to welfare, and uncertainty over the future of
the Eurozone, will 2012 be remembered for very different
reasons?
The SMF will be at the centre of the most relevant policy
discussions and debates at this year’s conferences. You
can play a part in this through following our live party
conference blog and Twitter updates, attending a
debate, or by partnering with us.

over a decade. Our events have become known for their
professionalism, high profile speakers and innovative
debates.
This, coupled with our independent, cross party
approach, makes us an excellent choice for any
organisation wishing to engage intelligently and
constructively in the issues facing policymakers,
politicians and the public at this crucial time.
Our themes document, now available to download,
outlines some of the hot topics that we would like to
debate this autumn and explains how you can work with
us this year.
To discuss ways that you can work with the SMF, please
contact our dedicated party conference manager, Rachel
Baker on 020 7227 4404 or RBaker@smf.co.uk.

We have been running successful and highly respected
fringe events at the major political party conferences for
Take a look at our Party Conference microsite, new for
2012 at www.smf.co.uk/events/party-conferences/
party-conference-themes or download a printable
PDF of the SMF’s 2012 Party Conference themes
document.

The Market Square
www.smf.co.uk/marketsquare
A market square is a social hub where people come together to
trade goods and chew the fat. The SMF's Market Square is an
ideas exchange, where the SMF team blog about the latest issues
and test out new thinking.
Get involved in the discussion by commenting on posts, voting on
our ideas, and sharing through social media.

Going cap in hand to the charities
Ian Mulheirn : 17 April 2012
The Chancellor’s budget decision to cap income tax relief has
caused a hullabaloo. Wealthy donors and their beneficiaries are in
open revolt, saying that charities will be hit hard by the measure.
And a lobbying alliance of the wealthy and the charity sector is
not something that politicians are likely to defy.
That there will be some cap seems certain. But in the face of this
firestorm the government has been curiously reticent in
defending its plan. Pointing to the need to curb the minor
problem of fraudulent charity giving understandably angered
many. There are good arguments for capping donations tax relief,
which tend to get less of a hearing. A look at the evidence also
points to some ways in which the Chancellor could appease the
charity sector while keeping most of his savings.

of donors.
So since charities get less than the government spends on tax
relief, the state has a dilemma. The cap is expected to save the
Treasury up to £100m per year from charity donors. So should it
spend that extra £100m on schools or the NHS, services that the
electorate as a whole (not just wealthy donors) want to see
provided? Or should it reverse its policy and spend that money on
tax relief for only £66m to go to privately favoured charities,
ranging from famine relief to donkey sanctuaries? The case for
doing the latter is perhaps weaker at a time when public services
are being cut to the bone and ministers lose sleep about the
government’s creditworthiness.
Nevertheless, the growing clamour now looks very likely to force
some kind of concession from the Treasury. And here the
evidence has interesting things to say about how the Chancellor
could recast his cap to make sure that government saves some
cash and charities maximise giving.

So what possible justification could there be for cutting tax breaks
on giving?

Recent research shows that how tax relief is offered really matters
to maximising donations. Where the charity directly claims the tax
rebate on behalf of the donor, as with Gift Aid, the scheme looks
more like a matching proposition. You give £1 and the
government will match it with a further 25p. Under Gift Aid for
higher rate taxpayers, the basic rate half of their tax break goes
straight to the charity in this way. But they reclaim their rebate on
the other 20% - the gap between basic and higher rate income
tax - through self assessment.

First it’s worth asking the question of how much charities actually
benefit from tax relief on donations. This depends how donors
respond. If they aim to give a fixed amount of their post-tax
income, regardless of government policy, then the charity can
expect to get the full value of any tax break that applies.

Field experiments indicate that the matching design can wring up
to three times as much in donations for every pound spent on the
match as the tax rebate version. And this is in spite of the fact that
economic theory would suggest that how the tax relief is
delivered should have no impact on donor behaviour.

But what if donors want the charity to get a fixed amount – say a
round million pounds? In this case, the availability of a tax top-up
might cause them to cut their net donation from what it would
otherwise have been. Here the donor benefits but the charity
does not. Cutting relief in the first case would hit the charity, but
in the second, the total received would be unchanged.

Yet under the government’s current proposal both parts of the
donors’ tax relief will be subject to the cap. This makes little sense.
The smart move for Mr Osborne would be to un-cap the tax relief
that boosts giving while screwing down the cap on the rebate.
Both the Big Society and the broke state would be the winners.

Which of these effects dominates is an empirical question. Several
studies suggest that charities get significantly less than £1 for
every £1 of tax relief paid out, because people reduce the amount
they give in response to the top-up. The evidence isn’t conclusive
but a reasonable approximation would be that perhaps two-thirds
of tax relief gets to the charity. The residual ends up in the pockets

This article first appeared on the New Statesman's economics
blog

Also on the Market Square:
A passport to the mainstream Ryan Shorthouse
Toll roads: A thin end of the wedge? Nigel Keohane